In case of credit sales, it attracts more customers, resulting in increased sales and higher profit, but it has a cost also.
a. Factoring In case of credit sales, it
attracts more customers, resulting in increased sales and higher profit, but it
has a cost also. This cost may be of two types, namely investment cost and
administrative cost. Moreover, the sellers have to raise funds from various
sources in order to finance the receivables. While maintaining receivables, a
firm may have to face two types of problems. First, the problem of raising
funds to finance the receivables, and second the problem relating to
collection, delay and defaults of the receivables. If the firm concentrates on
managing funds and receivables, it cannot concentrate on other functions like
finance, production, marketing, personal etc. Under this situation a firm can
avail the services of a specialist organization engaged in receivables management.
These specialist firms are known as factoring
Definition Factoring is a service that
covers the financing and collection of account receivables in domestic and
international trade. Factoring may be defined as the
relationship between the seller of the goods and a financial firm, called the
factor, whereby the latter purchases the receivables from the former and also
administers the receivables of the former. Factoring is an ongoing
arrangement between client and factor, where invoices raised on open account
sales of goods and services are regularly assigned to ‘the Factor’ for
financing, collection and sales ledger administration. Factoring is a financing
technique in which a business sells invoiced receivables at a discount to a
bank or a financing house or to an internal finance company. The factor may or
may not accept the incumbent credit risk. This is a service offered by a
factoring company that enables companies to sell their outstanding book debts
Companies Benefiting from Factoring Companies that typically benefit
from factoring include those that rapidly grow, seasonal, in start up mode,
under capitalized, those that have a lengthy manufacturing cycle, those
strained by slow turnovers of receivables, hurt by high bad debt losses and those
saddled with a large customer concentration.
How it works The factor fully manages your
sales ledger and provides you with credit control and collection services of
all your outstanding debts. The invoices you issue upon a sale are sent to the
factor that typically advances upto 80%
to 90% of the invoice amount to you. The balance, less charge, is paid when
the customer makes payment directly to the factor. These services are disclosed
to your customer who typically receives a letter from the factor, or attached
note to your invoice, containing payment instructions to the factor. Funds are
typically released to you with in 24
hours of issuing the invoices.
Cost involvement in factoring
Monetary Costs The factors are providing
advances to their client upto 80% to 90% of the invoice amount within 24 hours
of issuing invoices. For this cash advance they are charging interest. The
interest charges calculated on the daily usage of funds are typically
comparable to normal secured bank overdraft rates.
Service Charges The charge, which is known as
service charge, is expressed as a percentage of sales factored. The service
charge, covering sale ledger management, collection services, and bad debts
protection can range between 0.60% and
3.0% of turnover.
Types of Factoring Factoring
is a financial service provided by a factor firm to the client seller. The type
of factoring depends upon the terms and conditions on which the services are
provided, it is classified as follows:
This refers to those situations
where factor firms assume only the work of collection of the receivables. They
do not take any responsibility of bad
debts i.e. any loss due to delay or default by the receivables is borne by
the selling firms. In case the factor firm has already given advance to the
selling firm against the receivable, then the seller firm should reduce the
advance to the factor firm in case of default by the customer.
2. Non-Recourse Factoring It is also known as full factoring. Non-recourse factoring
protects against customers who fail to pay. The basic feature of non-recourse
factoring is that the risk of default is born by the factor firm and the
selling firm in any case receives the sales amount. Thus the factor typically
covers this risk by taking out credit insurance. The cost of the credit
insurance is passed on to the selling firm and depends on the risk profile of
your customer and the amount of your factor is typically between 0.3% and 0.7%
of turnover. The coverage limit with the factor is normally 80% - 95% of the
3. Other Types of Factoring Factoring may be advanced
factoring or maturity factoring. In the case of advance factoring 80 – 90% of
the receivable is paid by the factor to the seller within 24 hours of issue of
invoice and the balance less charges payable at the time of collection of
receivables. In the case of maturity factoring no advance is payable to the
seller, rather the payment is made only after collection from the customers.
Factoring Vs. Invoice Discounting If, the business has sufficient
staff and information system to manage the outstanding invoices efficiently and
then the firm may want to consider an invoice discounting rather than
factoring. It is identical to factoring except that in the sales ledger
management the collection responsibility remains with the firm and the service
is undisclosed to the customer.
Factoring and Internet Many factoring companies provide
Internet access to the seller, allowing you to constantly monitor your sales
ledger, balances, and individual customer details. Paperwork can be
eliminated by electronic transfer of your invoices.
Benefits of Factoring Better working capital
management: Since there is instant cash and 80-90% of issued invoices are prepaid within 24 hours the problem
of additional working capital required to match sales growth does not arise at
Management of receivables: Sales ledger management and debt collection is done by the factoring company. Improved growth: Firm borrows based on sales activity so firm can automatically set up to finance the growth of the company. Flexibility with financing: Factoring reveals and often replaces the traditional bank overdraft. In addition to all the credit management services, a factoring facility grows with the business and does not need renegotiating every time an increase is required. Better risk management: In case of non - recourse factoring, the risk of default is born by the factor firm and the selling firm does not assume any risk in connection with collection of money from the customers.
Factoring in India Factoring in India is of recent
origin. In order to study the feasibility of factoring services in India the
RBI constituted a committee in January 1988. The committee submitted its
response in January 1989 and RBI accepted its recommendation with specific
guidelines permitting banks to start factoring in India through their
In India, factoring is still not
very common and only a few commercial banks have established factoring
agencies. The first factoring i.e. the SBI commercial and factoring services
Ltd started working in April 1991. This company looks after the business of
Western India. The business of Northern India, Southern India and Eastern India
are being looked after by Punjab national bank, Canara bank and Allahabad bank
respectively. Honkong and Shangai Banking Corporation (HSBC) currently offer
both domestic and international factoring. When such banks are fully in operation, it will be a boon to
specially small and medium sections.
Forfaiting In February 1992, the RBI issued
guidelines for the introduction of forfaiting, which refers to factoring of
export receivables. It refers to discounting of future trade related
receivables under credit, made available by exporters to the customers.
b. Commercial Papers (CPs) Commercial Papers are debt
instruments issued by corporates for raising short-term resources from the
money market. These are unsecured debts of corporates. They are issued in the
form of promissory notes, redeemable at par to the holder at maturity. Only
corporates who get an investment grade rating can issue CPs as per RBI rules.
Though CPs are issued by corporates, they could be good investments if proper
caution is exercised.
c. Inter Corporate Deposits (ICD) Sometimes, the companies borrow
funds for a short-term period; say up to six months, from other companies,
which have surplus liquidity for the time being. The ICD are generally
unsecured and are arranged by a financier. The ICD are very common and popular
in practice, as these are not influenced by the legal hassles. The convenience
is the basic virtue of this method of financing. There is no regulation at
present in India to regulate these ICD. Moreover, these are not covered by the
section 58A of the companies Act, 1956, as the ICD are not for long term.
Tags : Financial Management - WORKING CAPITAL MANAGEMENT
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